A Bulletin of Socialist Economic Analysis published by Ken Livingstone
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Monday, 9 March 2015

Austerity did not even cut the deficit

By Michael Burke
The Coalition parties are set to feature deficit reduction as a central
achievement of their time in office as part of the election campaign.

The
economic crisis is driven by the excessive saving of the private sector - its
refusal to invest. As the government’s deficit is a response to this private
sector saving, cutting the government’s own spending is entirely the wrong
approach. It is the weakness of the economy that has caused the deficit, not
vice versa. The supporters of austerity look at the world through the wrong end
of the telescope and demand we all do the same.

It is also the case that the Coalition has failed even in its own terms. The
deficit has not been eliminated. The total deficit (excluding the effect of the
public sector banks, that is their bailout) was £153.5bn in 2010 and had fallen
only to £93.6bn in 2014. The deficit is far from being eliminated.

The discrepancy between the actual deficit and the forecasts made by the
Office for Budget Responsibility (OBR) and the Treasury at the time of the June
2010 Budget is shown in Fig.1 below. The official forecast was that the deficit
would be £60bn in the last Financial Year and would fall to £37bn in the current
Financial Year ending in April 2015. The actual deficit has been very different.

It was £97bn last year and will be an estimated £90bn in the current FY. The
government claimed it would reduce annual borrowing by £117bn and the fall has
been just £63bn, approximately half of what was promised.

Fig.1 Official forecasts for the deficit and the actual outturn

In addition the composition of the deficit belies any claim that austerity
has led to an improvement in public finances. In reality a combination of
accounting fiddles, reduced investment and inflation more than account for the
entire reduction in the deficit to date. None of these are supposed to be part
of the central design of austerity policies and none can be relied on to
sustainably lower the deficit. This is the case when the entire debate about
economic policy in the next five years is framed around even more austerity.

Investment, inflation and accounting fiddles

The factors reducing the deficit should be taken in order of magnitude. By
far the biggest contribution to the £60bn reduction in the deficit has been the
rise in VAT receipts, which have increased by £44bn over the period or by
approximately two-thirds of the total deficit-reduction. The Coalition increased
the VAT rate from 17.5% to 20%, but consumer prices have also risen by 12% in
the 4 years to 2014. This implies that the contribution from increased VAT rates
and inflation were approximately equal. Inflation has since subsided sharply and
unless the pound falls again is unlikely to accelerate again in the near future.

Despite great fanfare from Osborne and Cameron on the need for investment,
there has been no policy action that has made a larger contributor to the fall
in the deficit than the cut in government investment. This is shown in Fig. 2
below. In total the fall in net public sector investment from 2010 to 2014 was
£25.6bn. Even mainstream Tory opinion nods in the direction of the need for
increased public investment and only the most extreme ideologues explicitly
argue for cuts in this area. Even so this is the policy which has been carried
out to massage the total deficit lower. It is also in the clear hope that the
private sector will replace public investment, which has failed to take place.

Fig.2 Public Sector net investment

There have also been a number of accounting adjustments and outright fiddles
which George Osborne has conducted in order to get the deficit numbers down and
further measures of this type may be expected in the Budget later this month.
Perhaps the most scandalous was the £5
billion ‘pencilled in’ from an amnesty for tax evaders agreed with the Swiss
authorities which has yielded little more than £1bn. But the most substantial of
these fiddles is the £8.7bn in 2014 (and £18.6bn in 2013) from the Bank of
England’ s ‘Asset
Purchase Facility’ which are part of the wind-down of bank rescue operations
and nothing to do with current public sector income.

In other key items of revenue there are some important features. National
Insurance Contributions have risen by 11% and £11bn reflecting the growth of
employment during austerity. But the level of PAYE income tax has risen by just
5.9% (£7.7bn) as average pay has fallen and there has been no increase at all in
the tax revenue on self-assessed income (mainly from the self-employed), despite
more than half a million new ‘self-employed’ over the period. This confirms the
trend of low-wage, casual job creation.

It should also be noted that Corporation Tax revenues which are levied on
profits have actually fallen by £0.5bn over 4 years despite a £67bn rise in
nominal profits. This reflects the cut in the tax rate from 28% to 21% which
will further fall to 20% in April. The stated purpose of this cut was to spur
growth by encouraging business investment. But SEB has repeatedly noted
the fall in investment is the cause of the crisis and remains the main brake on
any recovery. Instead, the combination of the VAT hike and Corporation Tax cut
represented the key mechanism of austerity policies as a whole; the transfer of
incomes from poor to rich and from labour to capital.

Austerity was severe - it just doesn’t work as claimed

In terms of expenditure items, the total is considerably below the projection
first outlined by the Treasury and Office for Budget Responsibility in June
2010. It is therefore factually incorrect to state that austerity has not been
implemented, or has been not severe
enough. This is a fiction peddled by right-wing critics of the government.
But in June 2010 the Treasury/OBR forecast that total public sector current
expenditure would be £692.7bn in 2014/15 and in December this year they forecast
that the outturn would soon be £671.7bn. This is also a much tighter spending
policy than was planned given that inflation was higher than anticipated.
Austerity was applied even more severely than planned. It simply failed to
deliver deficit-reduction.

There was also a windfall to government accounts because of much lower debt
interest payments as global interest rates plummeted. The British government in
common with many others now receives money from investors who are lending to it,
paying negative interest rates. This lowered government outlays by £27bn
comparted to 2010 forecasts.

Yet the social security bill was also £28bn higher than officially forecast.
This serves to highlight a crucial point made at the time by the opponents of
austerity; that cuts aren’t savings. Given that the population continues to both
increase and age irrespective of fiscal policy, it was always certain that
outlays would grow. As austerity also leads to both slower growth and increased
poverty then key items such as social security will grow automatically.

By contrast the sole significant item of government expenditure which has
seen a fall in cash terms is transfers to local government, which has produced
both widespread hardship and increased likelihood of local government
bankruptcies.

The change to total Public Sector current Expenditure and the two key
components of higher social security and lower debt interest payments are shown
in Fig.3 below.

Fig. 3 Change from OBR Forecast to 2014/15 to total Public Sector Current
Expenditure and key components, £bn

Conclusion
Austerity damaged the economy austerity and did not even lead to deficit
reduction. The deficit has fallen due to growth – that itself has been stifled
by austerity.

However this nominal growth has been much more comprised of inflation than
real activity. This has created a one-off boost to VAT receipts, which is
unlikely to be repeated. The main policy change leading to a lower overall
deficit is the cut to public sector investment, which will prove highly damaging
in the long run. That aside, the Chancellor largely relies on accounting tricks
to massage the deficit lower.

There has been a very substantial windfall too from the fall in debt interest
payments, in common with nearly all the industrialised economies. This reflects
widespread economic weakness and fears of deflation. It is not a positive sign
about growth. The cuts have been even more severe than was first planned by the
Coalition when inflation is taken into account. But the supporters of austerity
ignore the crucial point that it creates economic weakness, which in turn leads
to both higher government spending and lower tax revenues.

The real cure for the deficit and for the economy is the same. Investment-led
growth will produce a sustainable increase in economic activity and under those
circumstances the deficit would take care of itself.